Academic journal article Public Finance and Management

ECONOMIC ORTHODOXY V MARKET PRAGMATISM: A CASE STUDY OF EUROPE'S 'ABANDONMENT' OF DEFENSE OFFSET

Academic journal article Public Finance and Management

ECONOMIC ORTHODOXY V MARKET PRAGMATISM: A CASE STUDY OF EUROPE'S 'ABANDONMENT' OF DEFENSE OFFSET

Article excerpt

1. INTRODUCTION

In 2009, the European Commission (EC) issued the Defense and Security Directive 2009/81/EC. This European Procurement Directive is intended to evolve a 'free' market in defense, equivalent to the single European market in the commercial sector. For this to happen, barriers to trade will need to be removed and open and free trade in military equipment promoted. This, of course, represents a major challenge. The arms market is unlike any other market. It is characterized by secrecy, high levels of government intervention, monopoly-monopsony industrial structures at the national level and oligopolyoligopsony structures at the global level. There is, moreover, another factor distinguishing the arms trade from most other markets, and this is that arms sales are inextricably linked to a phenomenon termed defense offset. This is where country-buyers of expensive military equipment demand some form of reciprocal benefit, such as technology transfer, local production and training - linked to the offshore vendor winning the sale. These additional benefits lead to second-level competition with respect to the attractiveness of the offset offerings. Whilst the demands for offset are legal, they are nevertheless controversial, not least because of the uncertainty as to whether its role should be driven by national security or economic objectives. The EC's position is that it adopts an orthodox ideological interpretation of offset, arguing that it is anti-competitive, trade-distorting and welfare-reducing, and, accordingly, offset between EC Member States is deemed illegal, in the absence of 'exceptional' national security reasons. Directive 81 aims to promote national security, ensuring that the primary defense contract is awarded purely on the effectiveness of the weapons system rather than on the attractiveness of the offset package, and separately that any offset sub-contract is determined solely on national security grounds.1

Prior to the Directive becoming law, several European states adopted a pragmatic position on offset, refusing to abandon the broad spread of offset opportunities when procuring foreign weapon systems. After all, beyond Europe, offset is ubiquitous, and this has led to several of the poorer and smaller EU states questioning whether they are being unfairly penalized, given that almost every country in the world, outside the EU, practices offset (O'Dwyer, 2013). This has led to a heated debate, especially in the face of a growing interest worldwide on the use of offset, and a clamor by states to introduce official offset policies. There are no official statistics on the use and value of offset, yet a recent estimate suggests that the rest of the world will rack up close to US$500bn worth of cumulative defense-related offset investment by 2016 (Avascent, 2012). 2 The purpose of this paper, then, is to evaluate the role and impact of defense offset, particularly in the context of the European Union. It examines the premise and logic behind the European Procurement Directive, and also its regulations that carry the potential of dramatically curtailing the use of offset in the European Union (EU). Admittedly early days, but this paper seeks to analyze the Directive's impact on Europe's defense industry; that is, whether the Directive is reducing the use of offset, or whether Member States continue to demand reciprocal benefits, either within the regulations or more disconcertingly, without. A conclusions section brings the paper to a close.

2. NATURE OF OFFSET

Offset may arise in two ways. Firstly, it may occur through flexible, sometimes termed variable (Taylor, 2004, p. 37) or non-mandated (Markowski & Hall, 2014) negotiated processes. Here procurement agencies base their decisions according to a two-envelope system where bidder compliance with the technical specification is considered in isolation from associated valueadding/value for money enhancements to the arms package; the latter including voluntary vendor offers, both related and unrelated, to the equip ment's capability requirements. …

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